Avinash Persaud's career spans finance, academia and policy advice. He was a top ranked sell-side analyst for 15 years and later a senior executive at J. P. Morgan, State Street and UBS GAM, before establishing Intelligence Capital Limited in 2005. He won the Jacques de Larosiere Prize from the IIF in 2000 for his essay on how trends in risk management and regulation were leading to systemic risks.He is an Emeritus Professor of Gresham College and Visiting Fellow at CFAP, Judge Institute, Cambridge. He was elected a Member of Council of the Royal Economics Society (2007), is a Governor and former Member of Council of the London School of Economics. Persaud is known for his work 'liquidity black holes' and investors' shifting risk appetite.

There is a long-standing tension between competition and stability in banking. In the UK, the IBC report promotes “challenger” banks to prise open a cosy banking oligopoly. But it was precisely those “challenger” banks like Northern Rock, HBOS, and Anglo Irish that introduced ‘dodgy products” and took most risks to build market share.

The main purpose of US regulatory laws after 1933 was to reduce competition in the name of stability and it would seem that we will always be stuck with this dismal trade-off. Which is not to say that zero competition or large uncompetitive banks are safe either. The trade-off is not linear. In general, larger institutions are more systemically important and should face a higher level of scrutiny and capital adequacy requirement to reflect this, which, perhaps, could create a choice for banks to stay mid-sized rather than grow large and that may then promote a little more competition and safety.

ALMOST every US economic recovery I have lived through has, at first, been labeled “the jobless recovery”. In the early phases of recovery when firms are uncertain as to the resilience of an incipient rise in demand, they try and squeeze as much output out of current employment and capital as possible before making the expensive and long-term decision to hire more workers. Consequently, recoveries are characterised by an initial spurt in productivity and stubborn unemployment, spawning stories by young journalists of how this time around, new technology has stolen our jobs for good and condemned us to jobless growth. Employment picks up later, spawning stories by older journalists of the enduring creativity of the US economy. On this basis, the recent drop in the unemployment rate, albeit long awaited, is a sign that firms are becoming more optimistic about the robustness of the US recovery. This is good news.

The fly in the ointment is that it has been a while since employment growth in the US has come from US firms winning the fierce battles of global competition. Instead, most employment growth over the past 20 years has come from sectors protected directly or indirectly from foreign competition, such as public-sector employment, employment in defence-related, health-related or finance-related sectors and other not easily tradable services. Given that all forms of government are in retreat and high oil prices and low house prices are deterring consumers from spending, scope for a sustainable rise in employment is more limited than it may at first appear.

IN THE clear light of morning, the legal or otherwise effective divorce between central bank and supervisory agency, or monetary policy and regulatory policy, was a mistake. At the root of the problem was an “institutional organisation issue” that could not be papered over by committees, meetings and crisscrossing lines of responsibility. Economists, in general, know more Greek than organisation theory.

The guards in the twin towers of monetary policy and regulatory policy surveyed their compounds as if the other did not exist. Over time there was greater specialisation, which made it is harder to see the blurred boundaries. Monetary policy was deliberately oblivious to the asset price boom—that was somebody else's problem. Regulatory policy was oblivious to macro risks—that was the central bankers job.

IT IS a politically appealing idea: that a main root of the financial crisis was growing income inequality. It was an idea espoused by J. K. Galbraith in “The Great Crash” for the 1929 stock market crash. And more recently, my friend, the brilliant Professor Raghuram Rajan of Chicago and previously chief economist at the IMF, has put it forward as a cause of the 2007 credit crunch. As I recall it, J. K. Galbraith was concerned that the economy had become fragile and vulnerable to swings because too great a proportion of national consumption rested on the consumption of a tiny minority. As I understand it, and in danger of gross oversimplification, Rajan's concerns are that increasing inequality prompts unsustainable activities like extensive sub-prime borrowing.

I think there is something in Rajan's argument, but only inasmuch as the politics of inequality influences the ability of policymakers to respond forcefully to the booms that seed the crashes.

THE concern that new banking regulation might crimp growth underscores the need to make banking regulation more countercyclical. We want regulation to be a drag on growth in the middle of a boom when lending and borrowing are at unprecedented levels and the growth we enjoy is unsustainable. We want regulation to facilitate growth in the middle of a recession when good lending opportunities appear sparse and growth is hard to rekindle.

The FSB and Basel Committee are working on making capital adequacy ratios more countercyclical but the technical difficulties are significant and not every one agrees, so it is likely to feature in “Pillar II” as a form of discretionary supervision. In this regard something is better than nothing, though we have tried discretionary regulation and it has been found wanting.

The other features of revised Basel II are tighter liquidity requirements, fewer exemptions on capital adequacy for, for example, the trading book, and capital adequacy for the holding of instruments that are not centrally cleared. These initiatives are all in the right direction, at last.

LET us for one moment strip away the party politics and focus on the economic fundamentals. A period of over-consumption, epitomised by lower than average savings rates, increasing leverage and large current account deficits in the US, UK, Spain and a few other countries, ending with an international financial crisis, can only be followed by a period of under-consumption. Attempts to maintain unsustainable levels of consumption by over-easy fiscal policy and directed lending will prove an unsustainable palliative. Indeed, we got into this fine mess by an earlier attempt to do just that, with the “Bush tax cuts” following the bursting of the dotcom bubble in 2000. The inability of the US Congress to raise taxes over the past ten years (or cut expenditure) is at the heart of global macro-economic imbalances—but that doesn't make for good politics.

Government does have a legitimate, fiscally activist, role to play. First, it should not impede the recovery through additional taxes or expenditure cuts. Secondly, it should seek to protect the most vulnerable in society, those who so who often have to clear up the mess of a party they were never invited to. Automatic stabilisers are sensible; balanced budgets at all times are not. But this is a limited agenda. Trying to do much more will likely get in the way of the adjustment in savings rates and balance sheets that has to take place before sustainable growth can resume.

COMPARED to when I first began writing about financial regulation ten years ago, the subject has been transformed from the tediously arcane to the deeply political. What else could come from a situation where previously self-satisfied, highly-paid and lightly taxed bankers are bailed out by governments that are then forced to make public sector workers redundant and to shelve programmes for the less well off—hardly God's work. It is entirely natural then, that the debates on bank taxes are driven by highly charged political sensitivities and not economic efficiency. But that is why you need a profession of dismal scientists to point this out and to say, for example in this case, that while taxes are part of the solution the proposed taxes do not solve the problem at hand.